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Three ways coronavirus is changing consumer behaviour

Equity Analyst, Sophie Lund-Yates looks at what the pandemic means for retailers, and what it could mean for the future of the industry.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please
seek advice. If you choose to invest the value of your investment will rise and fall, so you could get
back less than you put in.

Sophie Lund-Yates, Equity Analyst

1 May 2020

Lots of retailers have seen sales suddenly fall to zero overnight, while supermarkets have seen increases of up to 30%. Most well-run businesses will have a plan for when the unexpected happens. But swings in revenue of this magnitude cannot be planned for.

There’s no denying coronavirus has shaken up the retail sector, but often in ways investors might not have expected.

This article isn’t personal advice. If you're not sure what’s right for your circumstances, please ask for advice. All investments and their income fall as well as rise in value, so you could get back less than you invest. Past performance is not a guide to the future.

1. Supermarket sweeps can be painful

It stands to reason that supermarkets benefited from stockpiling behaviour. However, sales should level out in the fullness of time, and servicing extra sales means extra costs too. Whether it be bolstering online services or hiring tens of thousands of extra staff, a short, sharp spike in demand isn’t necessarily good news. We talk about this more in our recent sectors article.

Of course the likes of Tesco, Sainsbury, and Morrison have a key advantage in that they can continue to trade. The nation will always need food, so they’re in a much better spot than shops that have been forced to close. But it’s important to consider margins, sales trends before the outbreak, as well as how well placed they are to capitalise on the huge increase in demand for online shopping.

Tesco operating margin

Past performance is not a guide to the future. Source: Eikon accessed 23/04/2020

We’ve been particularly impressed with Tesco’s margin recovery following a difficult few years. We also tend to think the group’s well placed to handle the phenomenal extra costs associated with the disruption – not least because of the planned sale of its Asian business which will provide a cash injection of about £8.2bn.

And the emptying of supermarket shelves means more than just busier tills.

We’ve spoken before about diminishing brand power. Creating long lasting brand power has become more difficult, partly because of the surge in digital marketing and lower barriers to entry. There’s also downward pressure on prices as online competition causes us all to expect more for less. In all, we’re more likely to pick up an own brand product than we used to be.

That’s a problem for fast moving consumer goods (FMCG) giants like Unilever or Reckitt Benckiser, where sales have been steady and in some cases even flat despite recent stockpiling. We wonder if panic buying will have accelerated the consumer shift to own-branded products.

Bare shelves means someone who never considered buying Tesco own-brand bleach before, might have been forced to. We’re not convinced that same shopper will be persuaded to pay double the price for Domestos the next time they run out.

The FMCG companies are giants and we’re not saying the war is lost. But we think investors should keep an eye on underlying revenue trends for some of them. Looking out for the contribution from acquisitions is one way to do this. If sales are being driven by simply buying up the competition, it can suggest a company is struggling to create or sell the next generation of “must have” branded household goods.

2. “People do not buy a new outfit to stay at home”

Next’s CEO hit the nail on the head when he said this a few weeks ago. And the disruption means for the time being retail isn’t just a case of online vs. offline shops – people in lockdown don’t want as many clothes full stop. Retail sales volumes fell 5% in March, which was the largest monthly drop since records began.

Even shops that have an online presence are being forced to cancel orders with suppliers as unsold inventory stacks up. It’s a mistake to assume that lost sales from shuttered high streets have simply moved online too. Digital giant ASOS said sales in recent weeks were down as much as 25%.

Apart from the obvious issue that plummeting sales are bad for business, consumers and investors alike should pause to think what all this will mean once the dust starts to settle.

For one, there’s an entire season’s worth of unsold stock sitting in warehouses. Primark owner ABF said store closures mean inventory levels have swelled, and now sits at £1.5bn.

One way to deal with an unwanted pile of stock is to chuck it all on the sale racks – either online or in actual shops. This is a quick fix but comes with its own problems. If shops go down this route the amount of money they make, after taking into account what it costs to make and sell these goods, will come under pressure. The amount of discounting by businesses will vary on a case by case basis and ultimately depends on how much they can stomach.

This would be a particularly painful route to market for bigger department-store format shops. Their margins have already come under fire from increased discounting and the onerous costs associated with running their larger store estates.

Average item value

Calculated using exchange rates as at 23/04/2020

Source: Company results accessed 23/04/2020

As we prepare to emerge from lockdowns we think there are certain retailers that are in a better position than others. The first thing to consider is discretionary spending is likely to be squeezed as coronavirus has damaged global economies. Names like Primark and boohoo, which offer bargain prices could be better placed to capture demand, compared to more expensive high street offerings. Remember though, there are no guarantees.

The other thing to keep in mind is which retailers have the most wriggle room. If margins are already feeble it means they’re less equipped to deal with a downturn in sales.

3. Low-rent requests

The government has suspended business rates, which is a tax applied to commercial properties. Rents are another issue.

A company’s ability – or indeed willingness – to pay rent in these torrid times is between it and its landlord. We’ve heard that everyone from New Look to Burger King have requested a break or simply refused to hand over money as revenues slump to zero. Turning rent payments into a flexible (read cancellable) cost could do a lot to preserve cash.

Some businesses are in a better position than others when it comes to negotiating rent. As conditions on the high street have become more fraught we’ve seen record numbers of shops closing. So the select few that are still opening new space will have the upper hand. ABF and Next fall into this category – the latter’s new space grew by 98,000 sq ft last year.

New space added (sq. ft.)

Source: Next and ABF Full Year Results 2020, accessed 23/04/2020

Of course the other side of the coin is not such great news for landlords.

And all this comes at an already challenging time. Listed landlords such as Intu have been in the news already this year. The Trafford Centre owner’s tenants have really struggled as shopper footfall becomes weaker. And in March it warned it could breach its debt commitments as the outbreak piles more pressure on retailers.

Only 29% of rents due in April were collected on time compared to 77% this time last year. The shares have suffered, falling almost 90% in the last few months. We think things could still get worse from here.

Listed property company British Land has decided to help its retail tenants with rent delays. Although this will be painful, we think it’s ultimately the right thing to do. It’s better than forcing businesses to pay and then seeing them go out of business.

Because of this the REIT has suspended dividend payments. This type of company is usually obligated to pay out 90% of profits to shareholders. This usually makes them a favourite among income seeking investors, so this news was a big departure from the status quo.

The next few months will be really challenging. But for those that survive the shakeup in the industry, future growth will depend on how well positioned they are to keep up with a fast changing consumer base. Rebalancing the tenants on retail parks to more mixed-use activities is one way to do this. In the near-term the extent of the damage for landlords will depend on the number, and severity, of any damages to their key tenants.

Hargreaves Lansdown's Non-Executive Chair is also a Non-Executive Director of Tesco.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek
advice. If you choose to invest the value of your investment will rise and fall, so you could get back
less than you put in.

We look at why investors should beware of ‘cheap’ stocks and shares and pay extra attention to valuations at the moment.

Nicholas Hyett

01 Jun 2020 | 4 min read

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remember that investments can go up and down in value, so you could get back less than you put in.